8 October 2013
________________________________________________
Regulatory Framework for
Listed Company Audits
Information Paper and
Request for Comment
1
Executive summary
Regulation of listed company auditors is an important, but only one, part of the overall
system of regulation of the Hong Kong capital market. Under the existing system the
responsibility for auditor regulation rests primarily with the Hong Kong Institute of CPAs
(HKICPA). Internationally, over the last ten years there has been a trend of establishing
independent auditor regulatory and oversight bodies. In two key respects that are
explained in detail in the paper the Hong Kong auditor regulation system no longer
meets international benchmarks or expectation. It is important that this situation is
addressed to maintain the standing and reputation of Hong Kong's capital market and
auditing profession. The HKICPA is committed to playing its part in achieving this.
The HKICPA took an early lead in identifying necessary reform by research and outreach
activities in 2008 and 2009. In early 2010 a committee and a working group were set up
to develop proposals for reform of the auditor regulatory system and an initial proposal
was submitted to The HKSAR Government (Government) at the end of 2011. In early
2012 a joint proposal and timeline was developed with the Government and the Financial
Reporting Council (FRC).
The overall aim of reform is to establish an independent body to exercise oversight over
or assume direct responsibility for certain auditor regulation functions so that the
regulatory system in Hong Kong meets international benchmarks for regulation of listed
company auditors.
The HKICPA, the Government and the FRC have been involved in extensive dialogue to
develop a proposed draft framework (framework) for a revised regulatory system (Annex
1) that meets international benchmarks and is suitable for the purposes of consultation
with HKICPA members. The Government will conduct a public consultation subsequent
to HKICPA's member consultation.
The framework addresses the objectives of the reform exercise, key principles of
independent regulation and oversight and six recognized elements of auditor regulation.
In places, options for proposed changes are provided.
In this paper the HKICPA explains the key proposals in the framework and, where
appropriate, which options it prefers and why. The following summary highlights the
important proposals and explanations. Please also refer to the table (Annex 2) for
summary of key issues on regulatory functions under the proposed framework.
Oversight

To meet one of the key international benchmarks, any of the six elements of
regulation (registration, inspection, investigation, discipline, continuing professional
2
development and standard setting) that are not carried out directly by the
independent body will be subject to oversight by the independent body.

In respect of functions that continue to be carried out by the HKICPA under the direct
authority of the Professional Accountants Ordinance (PAO) and subject to oversight
by the independent body, the independent body will have reserved powers to direct
the HKICPA to take certain action if the HKICPA fails to act in the public interest.
Such powers should not be framed so as to give the independent body operational
control or "ownership" of the functions it oversees.
Registration

The HKICPA will remain responsible for registration of members and member firms.
The HKICPA will, subject to oversight by the independent body, maintain a separate
register of firms that audit listed companies and specified individuals in those firms.

Firms will not have to meet new criteria for registration although the "fit and proper"
tests for admission to membership will also be applied to listed company auditors.
Registration criteria will have to be re-confirmed as part of the annual renewal of
registration.

In certain circumstances Mainland and non-Hong Kong auditors have been and will
continue to be allowed to audit Hong Kong listed companies. These auditors will also
be included in the register. HKICPA's role as keeper of the register will be purely
administrative in relation to Mainland and non-Hong Kong auditors.

The HKICPA is of the view that under the new system attention must be paid to
ensuring that issues around effective regulation of Mainland and non-Hong Kong
auditors of companies listed in Hong Kong are addressed.
Inspection

The independent body will take over responsibility for inspection of audits of listed
companies and quality control systems of listed company auditors.

The independent body may delegate any of its inspection responsibilities to the
HKICPA, subject to direction and oversight.
Investigation

Power to investigate listed company auditors was moved from the HKICPA and taken
up by the FRC on its formation in 2006. No further action will be required by the
HKICPA.
Discipline and sanctions

The independent body will need to have sanctions available that allow it to take
timely and proportionate action to address poor quality audit work that could damage
public confidence in audit.
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
Notwithstanding the need to ensure an effective and efficient disciplinary mechanism
the fundamental principle of natural justice and fairness must always guide its
development.

To better assist the efficient administration of the disciplinary mechanism, there
should be an opportunity for the independent body to offer a sanction to the regulated
person to conclude the disciplinary matter without the need to convene a disciplinary
committee.

If no offer is made or an offer is rejected the matter should proceed to be heard
before a fully independent disciplinary committee or tribunal that should strictly abide
by the principles of natural justice and fairness:


o
No sanction should be exercised without due process;
o
There should be absolute transparency of process; and
o
Those responsible for the inspection or investigation of the matter should not
be part of the independent disciplinary committee or tribunal.
In respect of sanctions:
o
Clear guidance should be developed on sanctioning procedures;
o
We do not believe that a financial penalty, particularly one based upon a
multiple of profit or loss in an audit engagement, would be appropriate ; and
o
Where a fine is to be imposed, it should be proportionate and reasonable in
relation to the audit failing and should take into account any relevant factors
including the financial resources of the auditor, previous record and
admission of the failing and there should be a reasonable absolute monetary
cap.
There should be a right to have the decision of the disciplinary committee reviewed
by an independent appeals tribunal and, if a party to a review is dissatisfied with the
determination of the review, it should have the unrestricted right to appeal to the
Court of Appeal against the determination.
Standard setting

Setting auditing standards should remain the responsibility of the HKICPA, subject to
oversight by the independent body. The HKICPA has the experience, skills,
resources and international contacts necessary to carry out this function and a very
good track record of introducing high quality auditing standards.

The exercise of oversight should be no different from that on the areas of registration
and continuing professional development. There is no need for standards to be
endorsed by the independent body before introduction.
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Continuing professional development (CPD)

The HKICPA will continue to mandate CPD requirements for its members and
monitor compliance, subject to oversight by the independent body.
Funding

The HKICPA supports that funding should primarily be by listed companies and
investors. A registration fee should be charged to listed company auditors to cover
administration costs of maintaining the register.
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Introduction and objectives
1.
Regulation of auditors in Hong Kong has been the responsibility of the HKICPA
since it was first formed with powers under the PAO. Over the last ten years there
has internationally been significant movement of responsibility for auditor regulation
from professional bodies to independent oversight organizations. Hong Kong is
rightly proud of its status as an important and trusted international capital market.
Having a system of auditor regulation that can be seen to be independent from the
profession and benchmarked to other major jurisdictions is a key element in
maintaining that status.
2.
The HKICPA realised some years ago that the status quo was not an option if the
Hong Kong system of auditor regulation was to be recognized as equal to systems
in other jurisdictions. Reform is not being undertaken because of failings in the
current practice review programme which is fully benchmarked to international best
practices and there is no evidence to suggest that the HKICPA is not meeting
public interest expectations in its standard setting, qualification or educational
activities.
3.
In 2008 and 2009 we researched the international scene and reached out to
relevant bodies, including the International Forum of Independent Audit Regulators
(IFIAR), to establish what would be necessary to develop an internationally
accepted system. In early 2010 Council approved the establishment of a
committee and working group to develop proposals for reform of the auditor
regulatory system. This step was taken with the encouragement of Government
and an initial proposal was submitted to Government at the end of 2011.
4.
In the early part of 2012 a joint proposal for reform and timeline for action was
developed with the Government and the FRC. In early June 2012 HKICPA and
FRC representatives engaged with EC officials and the then IFIAR chairman to
establish that the proposed reforms would be significant move to achieving reform
objectives.
5.
For much of 2012 and 2013 the HKICPA has been engaged in discussions with the
Government and the FRC to develop more detailed plans for changes to the
auditor regulation system that achieve a position that is relevant to the Hong Kong
market and recognized internationally as an effective independent regulatory
function.
6.
Benchmarks used in assessing whether the proposed revised system would be
acceptable internationally remain the same as we established when we began our
work on reform in 2010, namely criteria for membership of IFIAR and requirements
for recognition as an equivalent regulatory system by the European Commission
(EC). The two common essential criteria are:

Inspection of Public Interest Entity (PIE) auditors must be the
responsibility of and subject to oversight by an independent body; and
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
Funding and governance of the oversight body must be independent of
the profession.
7.
The scope of reform remains as it has always been - Hong Kong listed company
audits and auditors. However, legislation to give effect to reform will refer to PIEs
as IFIAR membership criteria refer to PIE auditors. There is no internationally
agreed definition of PIE and in Hong Kong the only definition of PIE, in the Code of
Ethics for Professional Accountants, is listed companies. Under the revised system
PIE will be defined as only listed companies. Any subsequent changes will be at
the instigation of the independent regulator, subject to consultation with
Government, the HKICPA and other stakeholders. Therefore, for clarity we use the
term listed company rather than PIE throughout this paper.
8.
IFIAR is an increasingly influential organization. In 2011 IFIAR became a member
of the Monitoring Group, the body that oversees the auditing and assurance related
standard setting activities of International Federation of Accountants ("IFAC"),
monitors the activities of the Public Interest Oversight Board (PIOB), which
oversees the independent standard setting boards of IFAC, and convenes to
discuss issues and share views relating to international audit quality and regulatory
and market developments that have an impact on auditing. We believe that it
would be in the interest of Hong Kong to have a voice and influence in this forum.
9.
In addition to the two main criteria in Paragraph 5, EC equivalence provisions,
which are set out in the EU 2006 Statutory Audit Directive (SAD), require the
independent body to have oversight of all elements of the regulatory system that it
does not carry out itself. EC rules identify six elements of a regulatory system –
registration, inspection, investigation, enforcement/discipline, standard setting and
continuing professional development. Consequently all six elements have been
addressed in the reform process.
10.
Attaining EC equivalence does not require non-EU jurisdictions to have an auditor
regulation system that complies with all requirements of the SAD. The SAD sets
out very detailed requirements for statutory auditor regulatory systems in EU
member states and its provisions extend well beyond equivalence requirements,
which are only a part of the SAD.
11.
Non-EU jurisdictions that cannot meet equivalence requirements have been given
temporary transitional status to allow them to make appropriate changes to their
auditor regulatory systems. As of 1 August 2013 Hong Kong lost its transitional
status and the small number of Hong Kong audit firms registered with European
Union (EU) member state regulators will be subject to regulation by those
regulators, in respect of any audit clients listed in EU member states, unless and
until Hong Kong is given equivalence status. If these firms cannot re-assign their
audit appointments for EU listed clients to their local network firms they will be
inconvenienced by more stringent registration requirements and potentially direct
inspection.
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12.
However, the number of EU listed clients audited by Hong Kong audit firms is
relatively few and the extent and impact of direct inspection would therefore be
limited. We do not expect the number of Hong Kong audit firms with clients listed
in the EU to increase as we have not seen any strong interest for companies from
Hong Kong (and China) to list in the EU. Rather we expect the flow to be in the
opposite direction, a matter we address later in the paper.
13.
In our view membership of IFIAR will provide real opportunities for Hong Kong to
participate in and influence the international development of auditor regulation as
well as enhancing the reputation and standing of Hong Kong as an international
capital market. The benefits of EC equivalence will be primarily reputational.
14.
Our research has confirmed that among a number of key jurisdictions (UK, USA,
Germany, Australia and Singapore) that are members of IFIAR, members of EU
and non-EU countries recognized as equivalent by the EC the system of auditor
regulation varies in certain features. It is clear that there is no one model that Hong
Kong has to adopt to gain recognition. Therefore the new system of regulation,
while being benchmarked against international standards should also be relevant
and appropriate for the Hong Kong market.
15.
In developing proposals for a revised system all three parties have taken into
account the need to make the transition to a new system as smooth as possible
and to minimize operational disruption and additional regulatory and compliance
costs to firms.
16.
The HKICPA realizes that changing the system of audit regulation could have
significant and far-reaching effects on its responsibilities and activities and on the
future of the audit profession as a whole. We recognize that members may feel
uneasy with potential changes. As the representative of the audit profession in
Hong Kong the Institute is committed to working in the public interest with other
parties to ensure that the system of auditor regulation in Hong Kong supports the
reputation and status of its capital market and is fair to the audit profession.
17.
We are now seeking members' views on this important issue and have developed a
comprehensive engagement plan to ensure that all members fully understand the
background, the proposals and the HKICPA position. Following member
engagement and consideration of the outcome we will work with the Government to
draft proposed legislative changes for public consultation in 2014. The aim is to
introduce amending legislation to the Legislative Council in 2015.
8
Regulation of the Hong Kong Capital Market
18.
Auditor regulation is only one part of the overall framework that builds and
maintains confidence in the Hong Kong capital market. The current system of
listed company regulation involves a number of bodies (the Securities and Futures
Commission (SFC), Hong Kong Exchanges and Clearing Limited ("HKEx"), FRC
and HKICPA) that have regulatory powers and responsibilities in respect of
different activities of different market participants. We understand the concerns of
some commentators who have said that the current regulatory system is
fragmented and has a potential for inconsistent decisions and gaps and overlaps in
enforcement.
19.
The regulation of listed company auditors as significant service providers to listed
companies should be considered in the overall context of listed company and
market regulation. Audit is a significant, but only one, element of the financial
reporting supply chain and public confidence in financial reporting. This reform
process is only about auditor regulation but we take the opportunity to remind all
market regulators that there should be equally robust regulation of all elements of
the supply chain, including the preparers of financial information.
The proposed framework
20.
The Government has worked with the HKICPA and the FRC to develop a proposed
framework for a new system of independent regulation of listed company auditors
(Annex 1). All three parties consider that this document is suitable for the purpose
of consultation with HKICPA members but it does not represent a final position of
any of the parties.
21.
In places the proposed framework contains options. In this paper we offer
comments and views on our preferred options. Where we disagree with elements
of the proposed framework we explain why and offer alternatives.
22.
In the following pages the contents of the draft framework are addressed in the
order in which they are presented and references are made to the appropriate
section of the draft framework.
Broad principles of reform
23.
The principles and objectives of the reform process (Framework section A) are set
out in the above introduction. An independent oversight model is being proposed
to ensure that the Hong Kong auditor regulatory system is benchmarked to
international best practice and recognized internationally. The HKICPA fully
supports the introduction of a regulatory model that meets internationally
recognized criteria and enhances the standing and reputation of Hong Kong as an
international capital market.
9
Exercise of Oversight
24.
Aspects of regulation affecting listed company audits that are not carried out
directly by the independent body but remain with the HKICPA will have to be
subject to oversight by the independent body. This is necessary to demonstrate
EC equivalence but is not in IFIAR membership criteria. Assuming that the
independent body will directly perform inspections and investigations and will
establish procedures to allow it to exercise sanctions, enforcement and disciplinary
proceedings, the functions of continuing education, registration and standard
setting carried out by the HKICPA will be subject to oversight. There is no
evidence to suggest that the HKICPA is not meeting public interest expectations in
its standard setting, qualification or educational activities.
25.
Oversight can be applied in a range of ways, from controlling and mandating to
collaborative and guiding. We accept that for oversight to be effective the
independent body must be able to exert influence but believe that oversight should
be of the processes carried out and not interfere with executive decision making.
26.
The oversight models in the UK and Germany, two of the major economies in the
EU do not involve the independent bodies in day to day executive decision making.
The UK FRC oversees elements of regulation that it does not carry out directly,
including delegated inspection, primarily through an annual review of the activities
carried out by the professional bodies. An "on-site" review of process and samples
of work carried out, concluded by discussion and agreement on any necessary
action should be an effective and efficient use of resources of the HKICPA and the
independent body. .
27.
The description of the proposed oversight mechanism in the draft framework
broadly reflects these models and we believe it would be workable subject to the
comment below on reserve powers.
28.
We accept that for oversight arrangements to be seen to be effective and to ensure
the independent body is able to fulfill its own responsibilities the independent body
must have reserve powers, accompanied by appropriate checks and balances, to
direct the HKICPA to take specified action in the event that the HKICPA activities
do not address the public interest. Such reserve powers should be exercised in the
most exceptional circumstances and should not be interpreted to amount to
ownership of the functions by the independent body. We believe that more details
need to be incorporated into the draft framework to explicitly set out how the
independent body will exercise oversight and in what circumstances it will seek to
use its reserve powers.
10
Definition of PIE
29.
In the proposed framework PIE are defined for the initial introduction of the
reformed regulatory system as listed companies (Framework section B). The
HKICPA supports this position, which is in line with the international code of ethics
and there is no other definition currently available in Hong Kong; to extend beyond
listed companies would require extensive and delaying consultation with other
stakeholders. Subsequent extension of the definition of PIE may be proposed,
subject to appropriate discussion and approval mechanisms.
Registration
30.
The HKICPA will continue to maintain the register of all Hong Kong audit practices
(firms, corporate practices and own name). Information on the nature of client base,
including listed companies, will continue to be gathered through periodic
submission of the practice review questionnaire and updates. We support Option B
(Framework paragraph 7) where authority for the role is assigned directly to the
HKICPA by law, as is currently the position under the PAO, and not delegated by
the independent body.
31.
Under the proposed framework the HKICPA, under oversight of the independent
body, will maintain a sub-register of all Hong Kong based listed company auditors.
For the sake of clarity we have confirmed that the remit of the independent body,
and therefore registration requirements, will extend to all assurance engagements
currently required under HKEx Listing Rules. The register will also record all
practising certificate (PC) holders with responsibility for listed company audits, as
advised by the firm (Framework paragraphs 4(a) and 4(b)(i)). Registration of firms
and individuals responsible for listed company audits is common practice in other
jurisdictions.
32.
The HKICPA supports this proposal as two registers and sets of registration
requirements would be onerous for firms and difficult for third parties to
comprehend and it would be appropriate for the HKICPA to maintain and
administer the register of listed company auditors.
33.
The framework also proposes that the sub-register be extended to include
nominated engagement quality control (EQC) reviewers (or PC holders with
responsibility for EQC reviews) and the individual or individuals with ultimate
responsibility for systems of quality control in each registered audit firm
(Framework paragraphs 4(b)(ii) and (iii)). We recognize that EQC reviewers have a
position of influence and authority in respect of audit opinions on listed companies.
We agree that the definition of those responsible for EQC review included in the
draft framework is necessary to capture all individuals that fulfill this role as they will
not all be PC holders.
11
34.
We accept the proposal insofar as it is founded on the requirements of HKSQC 1.
In our initial engagement with member firms some expressed concern over this
provision but most now seem less resistant with the additional explanations and
linkage to HKSQC1 included in the draft framework. There will need to be
guidelines developed to clarify that action would be taken against the named
individual only in the event of a systemic and serious breakdown in the system of
quality control of the firm that leads to serious audit failures.
35.
The draft framework proposes that registration criteria for firms and individuals will
initially be the same as are currently set out in the Professional Accountants
Ordinance (PAO) but will be subject to regular reviews in the future. All registration
criteria will be reconfirmed at the annual renewal of registration.
36.
There is also a proposal that applicants for registration would have to meet "fit and
proper" criteria (Framework paragraph 6). In principle the HKICPA supports
extending fit and proper requirements to PC holders and applicants (currently it
applies to general membership). In our view the "fit and proper" test for registration
should be similar to the criteria we apply for admission to membership and should
not be confused with additional competence requirements.
37.
We are not aware that other significant jurisdictions have established additional
knowledge or competency criteria for qualified auditors to be admitted to a register
of listed company auditors. In most jurisdictions the eligibility criteria for statutory
auditors are similar to our PC rules and are set out in regulations or legislation.
Specific competencies relevant for auditors of listed companies e.g. knowledge of
Listing Rules, are assessed by inspection.
38.
To be comprehensive, the register of listed company auditors will have to include
non-Hong Kong audit firms (i.e. firms not registered with HKICPA or from the
Mainland and recognized under the H-share scheme referred to in paragraph 44)
(Framework paragraph 9) that currently audit companies listed in Hong Kong.
The current proposals are to "grandfather" currently recognized non-Hong Kong
firms and to keep recognition criteria for new applicants substantially as they are
under the current system.
39.
Setting registration criteria for non-Hong Kong audit firms will be the responsibility
of the independent body. The HKICPA role in maintaining the register, for nonHong Kong audit firms, is a straightforward administrative task. However, as a key
stakeholder and statutory licensing body, the new system should facilitate HKICPA
participation in the development of appropriate criteria by sharing knowledge and
experience about criteria for recognition of auditors.
12
40.
Currently, recognition of non-Hong Kong auditors is governed by HKEx Listing
Rules. Under these provisions HKEx has allowed some newly listed foreign
companies to engage non-Hong Kong auditors (Main Board Listing Rule 19.20:
"the firm of accountants acceptable to the Exchange which has an international
name and reputation and is a member of a recognised body of accountants".).
41.
At the end of December 2012, the number of non-Hong Kong auditors accepted by
the HKEx under Rule 19.20 was 17 firms auditing 24 companies. However, given
the policy of HKEx to attract non-Hong Kong incorporated companies to list in Hong
Kong the number of non-Hong Kong auditors of companies listed in Hong Kong is
likely to increase.
42.
The draft framework proposes to replace Listing Rule 19.20 with two specific
criteria and "other relevant factors" relating to the capability of the non-Hong Kong
auditor to carry out a satisfactory audit, to be assessed by the independent body
(Framework paragraph 9(b)). In our view this does not give sufficient clarity about
how the suitability of a non-Hong Kong firm will be addressed. We also believe
that retaining the Listing Rule requirement for an audit firm to have an international
name and reputation is appropriate.
43.
The Hong Kong capital market is a very open market and has attracted a number
of overseas companies to list in Hong Kong. As explained above there are existing
provisions to allow non-Hong Kong auditors to audit these companies and this
practice will continue. We have been assured by the other parties that there is no
intention to accept more overseas auditors into the Hong Kong market without a
stringent screening process and there will be no automatic jurisdictional recognition.
Applications to retain their local auditor by overseas companies wishing to list in
Hong Kong will continue to be dealt with on a case specific basis and an overseas
auditor's registration will only relate to that company.
44.
From 2010 the arrangements to allow H-share companies to file financial
statements prepared under Chinese Accounting Standards for Business
Enterprises (CASBE) and audited by Mainland auditors have also been effective
(Main Board Listing Rule 19A.31: "a firm of practising accountants which has been
approved by the China Ministry of Finance and the China Securities Regulatory
Commission as being suitable to act as an auditor or a reporting accountant for a
PRC incorporated company listed in Hong Kong".). The list of the 12 firms
currently approved by MoF/CSRC is available on the HKEx website.
45.
The current arrangements for H-share companies and their auditors will remain and
will not be amended as part of the reform process (Framework paragraph 10). We
recognize that the arrangements have only been introduced at the end of 2010 but
we believe that the current audit regulation reform is an opportunity to address the
situation where three different groups of auditors (Hong Kong, Mainland and nonHong Kong) are recognized and regulated by different bodies under different
criteria.
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46.
We suggest that at a minimum the independent body should commit to a positive
and proactive role in ensuring transparency and sufficiency of regulation of all nonlocal audit firms.
47.
The potential difficulties of a national regulator effectively exercising its powers over
auditors who are active but not located in the same jurisdiction have been put in the
spotlight in the last few years, internationally and within Hong Kong. These
circumstances also give rise to potential investor protection issues that have yet to
be fully explored, including how an investor or liquidator could pursue an action
against an auditor outside of Hong Kong through the auditors own domestic legal
system.
48.
We believe that until further serious consideration has been given to ensuring the
effectiveness of cross border regulation, confirming that local and non-local
auditors are regulated in an equitable manner and maintaining appropriate levels of
investor protection, no steps should be taken that potentially accept into the Hong
Kong market even greater numbers of non-Hong Kong auditors.
Inspection
49.
We accept that to meet international expectations and benchmarks the
independent body will assume statutory responsibility for inspection of listed
company auditors (Framework paragraph 12). The scope of inspection activities
will include review of firm-wide quality control policies and procedures and
completed listed company audit engagements. The HKICPA will continue to carry
out practice review on all audit practices and engagements not covered by the
independent body.
50.
The HKICPA will continue to have responsibility for review of non-listed company
engagements in a listed company auditor. To minimize duplication of work and
ensure effective regulation the independent body and the HKICPA will share their
inspection results (Framework paragraph 13).
51.
IFIAR and EC criteria allow for a professional body to continue inspecting listed
company auditors under supervision and direction of an independent oversight
body. However, we recognize that in most significant jurisdictions the independent
body takes all, or a significant, responsibility for direct inspection. The UK is a
notable exception where the UK FRC has recently taken the step of delegating
more inspection work back to the professional bodies. There needs to be full
consideration of the extent of direct inspection by the independent body that would
be most effective in Hong Kong.
52.
We believe that delegation of some elements of inspection work by the
independent body to the HKICPA would be an effective and efficient use of
resources and a practical way to manage the transition to the new system and to
build appropriate skills and experience in the independent body.
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Investigation
53.
HKICPA powers to investigate members and firms concerning audits of listed
companies were transferred to the FRC on the establishment of the FRC in 2006.
The reform process will have no impact on the HKICPA in respect of this element
of regulation. (Framework paragraph 15)
Sanctions / Discipline
54.
We recognize that the key objective in establishing an effective enforcement and
disciplinary system is to achieve an appropriate balance between efficiency and
procedural fairness. Discussions about enforcement powers for the independent
body have covered many possible models with different balances of these key
elements. The proposed framework includes three options (Framework paragraph
16).
55.
Option A proposes direct sanctioning and enforcement powers for the independent
body based on the models for other regulatory bodies in Hong Kong. Whilst we
recognize the potential benefits in operational efficiency, introduction of this model
would be a significant move away from the current system under the PAO where
the disciplinary process is completely independent of the inspection (and
investigation) processes. We believe that as a matter of principle there should be a
fully transparent separation of responsibilities between inspection (and
investigation) and discipline which will not be achieved if all activities are
undertaken directly by the independent body.
56.
Duplicating an enforcement and sanctions model from another Hong Kong
regulatory body would not be entirely appropriate. Regulation of auditors, including
the enforcement regime, should reflect that auditing standards are principles and
not rules based and that the audit process requires significant exercise of judgment
by the auditor. The audit process and expression of an audit opinion is a very
different activity to the services provided by other regulatees within the financial
market, which very frequently are subject to a more rule-based regime.
57.
Option C proposes a disciplinary committee with an independent majority and the
right of appeal to an independent tribunal. However, we are concerned that the
proposal envisages the disciplinary committee being convened and chaired by the
"senior executive" of the independent oversight body. In our view there is a serious
conflict in the same individual leading the inspection and investigation functions
and participating in the disciplinary committee that deliberates on cases based on
inspection findings. Acting as chairman of the disciplinary committee will aggravate
the conflict as in reality the chairman is in a position to exercise significant influence
over the deliberations and decisions of the committee. .
15
58.
We support Option B, which has very clear features that demonstrate that a
disciplinary committee is completely independent of the inspection and
investigation body. Our research indicates that Option B also reflects the
disciplinary arrangements of the other main professions in Hong Kong (medical,
legal and construction) which have a complete separation of investigation and
disciplinary processes, a fair hearing at the disciplinary stage and a right of appeal.
59.
We accept that there may be a process by which the independent audit oversight
body can conclude a disciplinary matter with a regulated person by offering an
appropriate sanction before a disciplinary committee is convened to deal with the
case (Framework section 19)). The regulated person should be free to accept or
reject the proposal. In the event that the regulated person rejects the proposal, the
matter should proceed to be heard before the disciplinary committee without
reference being made to the rejection of the proposal. Any sanctions proposed and
accepted would be publicized in the same way as a disciplinary committee decision.
60.
Such arrangements are not inconsistent with our support of Option B and assists in
achieving a balance between efficiency and procedural fairness. A case can only
be concluded by offer and acceptance of a sanction as opposed to a decision by
the independent body which the auditor may appeal against.
61.
We understand there are concerns within the investment community that an
entirely internal disciplinary process that is not transparent may be misused to
manipulate caseload and results. Therefore we suggest that any disciplinary
powers exercised directly by the independent body, whether initial decisions under
Option A or settlement offers under Option B, are subject to oversight and annual
review by the independent appeal tribunal to check consistency and
appropriateness of the use of such powers. The disciplinary process should also
be transparent and given adequate publicity.
62.
The draft framework indicates that a disciplinary committee will consist of three
persons, including the chair. We understand that requiring relatively few members
to constitute a committee may be preferable for ease of administration. However,
we suggest that increasing the size of a disciplinary committee to five members
would increase the perception of a fair and open hearing. We also believe that, to
ensure a disciplinary committee has the appropriate level of knowledge of
professional standards and practice, any accountants appointed to the committee
should be members of the HKICPA.
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63.
We suggest that to encourage participation of suitably skilled and experienced
individuals in the disciplinary process and to address concerns about excessive
delays in disciplinary proceedings when all participants in the process are providing
their services free of charge, consideration should be given to introducing a
scheme for remuneration of disciplinary panel members. This could be further
strengthened by retention of committee chairmen on a more permanent basis. To
maintain independence remuneration of committee members and chairmen should
come from an independent fund.
64.
We support the proposal that decisions of disciplinary committees and the
independent body may be appealed to an independent tribunal (Framework
paragraph 17(d)). We do not believe that there should be any restrictions on the
right of a respondent to appeal a decision of the independent tribunal to the Court
of Appeal or that such appeal can only be made with leave of the Court of Appeal
(Framework paragraph 17(f)). This would significantly reduce the rights of appeal
that are currently available to members and firms under the PAO.
65.
We believe that there must be clear proceedings rules to govern disciplinary
activities whether carried out directly by the regulator, by a disciplinary committee
or an independent tribunal and there must be absolute clarity that a respondent has
the right of a full hearing, in person, before all bodies. In our view the expression in
the framework giving "a reasonable opportunity of being heard" does not provide
such comfort. Given the nature of audit work and in particular the exercise of
judgment in the audit process an auditor accused of a failure in audit work should
be allowed sufficient time and a full hearing to adequately present a defence
supported by such relevant materials as the auditor should think fit.
66.
Our research on enforcement powers available to listed company auditor regulators
in other jurisdictions indicates that there is a fairly common range of sanctions,
most related to the registration or licence of an audit firm or individual. A typical
range of sanctions available to an independent regulator is:
 Conditions placed on the continuing ability of the auditor to continue to
undertake audits e.g. required to implement specific procedures or
undertake specified training;
 Restrictions placed on the continuing ability of the auditor to continue to
undertake audits e.g. not allowed to undertake audits of a specified type
of entity for a prescribed period of time;
 Suspension of licence/registration for a period of time, often conditional on
completing specified remedial action;
 Withdrawal of licence/registration; and
 Monetary fines.
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The range of sanctions included in the draft framework (Framework paragraph 18)
broadly follows this example and in principle we support the proposed range of
sanctions.
67.
The most serious sanctions (suspension or withdrawal of registration and fines)
should only be applied when there is no other effective sanction available and to
allow the auditor to continue to audit listed companies would not be in the public
interest. In our view, the most serious sanctions should only be exercised by an
independent disciplinary committee or tribunal.
68.
Fines and financial penalties are of a punitive nature, as opposed to other types of
sanction used by regulators which are clearly focused on remedial action and
protecting the public. We disagree in principle with the use of financial penalties as
a punishment as the reputational damage to an auditor, and the potential prompt of
civil action as a result of any regulatory action, is in itself a sufficient deterrent..
69.
We recognise that the proposed multiple of three times (Framework paragraph
18(d)) profit made or loss avoided as an alternative cap on the amount of fines
reflects provisions for maximum fines in the powers of other Hing Kong regulators.
However, profit or loss in an audit engagement may not be a fair reflection of the
culpability of the auditor and may result in excessive monetary amounts.
70.
If the range of sanctions available to the independent body does include monetary
penalties the maximum amount should be set at a reasonable level. The provision
of monetary penalties in the range of sanctions is designed to allow punishment
and deterrence, not compensation for loss which will still be pursued by any parties
incurring loss through civil actions.
71.
For many audit firms in Hong Kong that audit listed companies the proposed cap of
$10,000,000 is an amount that if applied would threaten the continued existence of
the firm. There needs to be clarity that the principle of proportionality would
always be applied in determining the amount of a fine. Sanctions such as
suspension or withdrawal of registration are the appropriate mechanism to curtail
an auditor's ability to carry out listed company audits, not fines.
72.
Given the variation in size among firms that audit listed companies, we have also
been advised that the imposition of a penalty that is close to the maximum will
seriously threaten the viability of even some sizable firms or that simply the threat
of a maximum $10,000,000 penalty may result in them withdrawing from the market
for listed company audits due to a lack of confidence in how the power will be used.
Reducing choice in the market for listed company auditors would not contribute to
the healthy development of the audit market, which already shows a high degree of
concentration.
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73.
We believe that guidance needs to be developed on sanctioning procedures and
application similar to that published by other Hong Kong market regulators and
overseas audit regulators. All fines should be proportionate and reasonable in
relation to the audit failing and be calculated by reference to a number of factors
including the financial resources of the auditor, previous record and admission of
the failing.
74.
We believe that a reasonable absolute monetary cap and reference to appropriate
factors in determining the amount of a penalty would be acceptable and easy to
understand and administer.
75.
We support the proposal that financial penalties recovered will be paid to the
Government rather than the independent body to enhance and emphasise the
impartiality of the process (Framework paragraph 20).
76.
The HKICPA recognizes that a regulator requires enforcement powers that create a
regulatory environment in which, after consideration of all relevant factors (e.g.
prejudicial effect on on going criminal or civil proceedings), timely, appropriate,
proportionate and effective action can be taken in response to audit failings.
However, we are of the view that all sanctions should be proportionate and
reasonable, no sanction should be exercised without due process and there should
be absolute transparency of process and clear separation of responsibility for
inspection and sanction.
77.
We believe that the reform exercise presents a good opportunity to also consider
whether new sanctions should be introduced to complement existing HKICPA
practice review committee powers and disciplinary processes. Any such changes
should be benchmarked to enforcement powers of other leading professional
bodies and should be largely consistent with the powers taken up by the
independent body.
Standard setting
78.
We believe that the HKICPA should continue in its role as the setter of auditing
standards and the code of ethics in Hong Kong, subject to oversight by the
independent body, and that it is neither appropriate nor necessary for the
independent body to take over that responsibility.
79.
Auditing standards in Hong Kong (HKSAs) have been fully converged with
international standards (ISAs) since 2005. We see no need to move standard
setting from the HKICPA where there is an established, efficient and broad based
mechanism, funded by member subscriptions, for involvement in the whole
international standard setting process and local adoption. Standard setting is a
specialized and highly technical activity that would take a significant amount of time
and resources to develop and maintain in another body.
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80.
The HKICPA has well established relations with the International Audit and
Assurance Standards Board (IAASB) and the International Ethics Standards Board
for Accountants (IESBA) to ensure that Hong Kong has a real and influential
involvement in international standard setting. The standard setting processes and
procedures of the IAASB and IESBA are already subject to independent oversight
by the PIOB and the Monitoring Group.
81.
The standard setting process of the HKICPA is fully transparent and aligned with
international procedures. Exposure and adoption of new or revised standards is
carried out concurrently with IAASB and IESBA processes.
82.
There is only one set of auditing standards in Hong Kong, applying to audits of nonlisted and listed companies. The approximately one million Hong Kong companies
that are not listed are completely outside the scope of this reform. It would not be
appropriate for the independent regulator to take responsibility for setting standards
for the audits of this group of companies.
83.
We have sought to understand how oversight is exercised in EU countries where
the independent body oversees, but does not directly carry out, standard setting.
In Germany, auditing standards are set by the professional body subject to what
seems to be a fairly "light touch" oversight by the independent regulator. A
representative of the regulator sits on the standard setting committee. The
HKICPA's Audit and Assurance Standards Committee has for a number of years
included members representing the FRC, SFC and HKEx. The standards issued
by the German professional body do not require endorsement or "no objection" by
the oversight body.
84.
We therefore support Option B (Framework paragraph 21) where authority for the
role is assigned directly to the HKICPA by law, as is currently the position under the
PAO, and not delegated by the independent body. We are of the view that the
proposed oversight mechanism gives the independent body appropriate reserve
powers and that there is no need for specific requirements for the independent
body to endorse standards before they are issued (Framework paragraph 24). The
independent body will also continue to have representatives on the HKICPA
standard setting committees and will be involved in and able to influence the
process by this means.
85.
Option A and the proposal that the independent body should endorse standards
effectively would give the independent body ownership of standard setting. This is
more than is required to meet EC equivalence requirements.
86.
The HKICPA standard setting process is well established, effective and efficient.
There has been no suggestion that the existing process has failed to produce
relevant and high quality standards. We see no reason to disturb the status quo
other than introducing an appropriate mechanism of oversight by the independent
body.
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Continuing professional development (CPD)
87.
The HKICPA will, subject to oversight by the independent body, continue its role of
setting and monitoring compliance with CPD standards and requirements for its
members. We support Option B in respect of the source of authority for the role
and the proposed oversight arrangements (Framework paragraph 25).
Funding
88.
Based on our research it is apparent that the source of funding of an independent
regulator is less relevant in determining that the body is independent of the
profession than the control of budgets and strategy. Many IFIAR member bodies
obtain part of their funds from the profession.
89.
We believe that, as the independent body will be concerned solely with audits and
financial statements of listed companies, it would be reasonable to propose that the
future operations of the independent body should be funded primarily by listed
companies. We therefore support the proposed funding mechanism in the draft
framework (Framework paragraphs 27 to 29). Levies on listed companies and
transactions should be collected on behalf of the independent body by bodies with
existing direct regulatory relationships with the relevant parties i.e. SFC and HKEx.
This paper sets out the views of Council on the proposed framework of key reform
proposals, including preferred options where options are provided in the
framework, and explains the reasons why Council has reached these views. You
are asked to comment on the framework and confirm if you support Council's
views. We would be pleased to hear from you if you have any additional
arguments to support Council's views. If there are any aspects of the views
expressed, the reasoning behind them or the framework itself that you do not
agree with please contact us with your thoughts.
Your comments should be submitted by 10 January 2014 to the Hong Kong Institute of
Certified Public Accountants:
37/F, Wu Chung House
213 Queen's Road East, Wanchai
Hong Kong
Fax: (852) 2865-6603 or 2865-6776
Email: regulation@hkicpa.org.hk
Please mark the subject line: Regulatory framework for listed company audits
We will publish responses on a named basis in the intended consultation
conclusions. If you do not wish your name to be disclosed to members of the
public, please state so when responding to this paper. Our policy on handling
personal data is available on the website www.hkicpa.org.hk.
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